Growth has been satisfactory in the Estonian economy given the difficulties in several of Estonia’s main export markets

Growth is accelerating to between 3% and 4%, which is the current growth potential

Stresses have not increased in the labour market, but falling company profits are a warning sign

Growth is speeding up in Estonia, but it remains slower than before the crisis, and growth of 2.2% this year is about the same as last year. It will be 3–4% in the next two years, which is the same as the long-term growth capacity of Estonia. Faster growth is restricted by the decline in population, and by the current structure of production, equipment and production technology, which are more complex and costly to add to than was the case before. Without structural reforms to support growth, it could only exceed 4% temporarily, and probably at the cost of the economy overheating.

As several key markets for exports from Estonia are facing difficulties, the growth in the Estonian economy last year can be seen as satisfactory. The outlook for economic growth in the years ahead has not changed much since the December forecast as the exporting sector has so far proved able to cope successfully with the difficulties it has faced. Although exports to Russia have more than halved and the negative impact from Russia is also felt in the Estonian economy through other trading partners, export volumes have still increased.

The fall in Russia’s share of foreign trade has been offset by an increase in the share of Sweden and the euro area, and this change will benefit Estonia in the near term. Growth in the euro area has been rejuvenated by the weak euro, improved competitiveness, lower unemployment, expansive monetary policy, lower credit barriers, and a reduced need to consolidate public sector budgets.

Economic growth in Estonia has been aided above all in recent years by strong domestic consumption. Consumption has primarily increased because household incomes have risen, as both employment and average wages have climbed faster than increased output from companies might have indicated. Despite the strong growth in wage costs, companies generally find that their competitiveness in the European Union market has improved, which suggests that non-price competitiveness has improved and Estonia’s advantage as a producer lies in more than cheap labour resources.

Rising employment and an unchanged vacancy rate indicate that the pressure for wage rises has not increased. The unemployment rate has fallen to the level it was at during the boom and the number of long-term unemployed has also fallen. The number employed will fall next year, but from 2017 it will shrink more slowly than the working age population because of the work capacity reform that will come into force in 2016. Many of those who will be entering the labour market because of the reform do not have appropriate skills or knowledge, so the unemployment rate will rise as a consequence of the reform.

The fall in corporate profits points to the risk that investment and a building up of the economy’s capacity for growth could become more complicated. This could happen if the fall in profits that happened last year were to continue for a longer time. Corporate profits can mainly be increased by a rise in productivity, which would require investments in efficiency and product development. Investment in more efficient production is also vital because of the decline in the population of working age. Credit conditions continue to favour financing for investment and further growth in it.

The fall in consumer prices that started last year has benefited Estonia. The fall in the price of energy sources has had a positive effect, as Estonia imports more fuel than it exports. Cheaper energy has benefited the Estonian economy more than others because it uses relatively more energy than other countries.

Inflation will pick up in the second half of this year, as prices will start to rise for food and energy. Prices will be lifted further in the next two years by the planned rise in consumption taxes. On top of the rise in the prices of domestic production, which is being driven by wage rises, the depreciation of the euro has led prices of imported products to start rising faster.

The Estonian government’s fiscal policy needs to be sustainable to provide stability for a small and open economy that is exposed to risks from the external environment. The government can only act countercyclically and mitigate the negative effects of risks if there is sufficient fiscal space. The new government that took office in the spring confirmed in its budget strategy that is determined to keep the budget in balance over the medium term. The Eesti Pank forecast finds that it is possible for balance to be achieved in broad terms. The budget will remain slightly in structural deficit throughout the forecast horizon because planned social benefits and investment will lift spending above the long-term balanced level of revenues. The new coalition has continued with the strategic goal of shifting the tax burden from labour to consumption. It is important to make sure that sharp or unexpected tax changes do not increase uncertainty among consumers or companies.

Economic growth will accelerate slightly in the coming years, and the risks surrounding it are more likely to reduce growth. The main risks to the outlook for growth come again from the external environment, such as trade restrictions and continuing geopolitical tensions between Russia and the European Union, or the recovery of the global economy and the increasing role played by emerging economies in the rate of it. The large volume of investment in the economy is exposed to the risk that the ability of the banks to get funding could suffer if asset prices in the Nordic countries were to start to fall.

According to the second estimates of Statistics Estonia, the gross domestic product (GDP) of Estonia increased 1.1% in the 1st quarter of 2015 compared to the 1st quarter of the previous year.

In the 1st quarter, the GDP at current prices was 4.7 billion euros. The seasonally and working-day adjusted GDP fell 0.3% compared to the 4th quarter of 2014 and rose 1.7% compared to the 1st quarter of 2014.

In the 1st quarter of 2015, the GDP was driven the most by a rise in value added in manufacturing, which was mainly due to the increased manufacture of electronic products and products of wood. At the same time, the growth of manufacturing was substantially negatively influenced by the decrease in the manufacture of food and paper products. Manufacturing, which is the largest economic activity in Estonia, was the biggest contributor to the GDP growth for the third quarter in a row.

In the 1st quarter of 2015, similarly to the previous quarter, the Estonian economy was inhibited the most by the decrease in value added in transport. The earlier decline was mainly due to the decline in warehousing and support activities for transportation. This time, the decrease was mainly caused by the decline in land transport.

Real GDP grew slower than the number of persons employed and hours worked (which grew 3.6% and 4.5%, respectively). Therefore, labour productivity per employee and per hour worked decreased for the second quarter in a row.

The labour costs for GDP production have increased. In the 1st quarter of 2015, unit labour costs increased 7% compared to the same quarter of the previous year. Consequently, compensation per employee has grown substantially faster than productivity.

The exports of goods of both manufacturing and the total economy increased in the 1st quarter of 2015 compared to the same quarter of the previous year. The exports of goods and services increased for the fourth quarter in a row, being influenced the most by the increase in the export of electronic products, coke and refined petroleum products and by the decrease in the export of other machinery and food products. Compared to the same period of the previous year, the import of goods and services decreased by 2.9% at real prices. Net export (i.e. the difference between export and import) was positive in the 1st quarter of 2015, amounting to 3.3% of the GDP.

Estonia’s economy was positively influenced by external demand and negatively influenced by domestic demand. Domestic demand decreased 1.6% at real prices, mainly due to the gross fixed capital formation and changes in inventories. In the 1st quarter, gross fixed capital formation decreased 7.7% at real prices, mainly due to the decline in the investments of non-financial corporations in machinery and equipment and in transport equipment. The remaining components of domestic demand contributed positively to economic growth.

Since the implementation of the ESA 2010 methodology in September 2014, Statistics Estonia and Eesti Pank harmonised their revision policy of national accounts and balance of payments estimates. In conjunction with the publication of the estimates for the 1st quarter of 2015, the estimates for the 4th quarter of 2014 were also revised. Compared to the indicators published on 11 March 2015, Statistics Estonia revised the real growth of the GDP in the 4th quarter of 2014 downwards by 0.01 percentage points.

On 8 September 2015, Statistics Estonia will release the regular revision for 2011–2014 based on supply and use tables and annual business reports. The updated data for the 1st quarter of 2015 will be published on the same date. In addition, the time series for 1st quarter 1995 – 4th quarter 1999 revised according to ESA 2010 will be published for the first time.

According to the second estimate of Statistics Estonia, GDP growth decelerated to 1.1% in real terms in the first quarter this year. Compared to the previous quarter, seasonally and working day adjusted GDP decreased by 0.3%. GDP decreased two years ago the last time.

Manufacturing sector, primarily electronics and wood production, contributed the most to the economic growth already third quarter in a row. At the same time, production volume of electronics has decelerated this year. The growth of the manufacturing sector was inhibited by the decrease in the value added of food, paper and chemicals’ industry. Main reason is the drop of exports to Russia, in case of chemicals to Latvia, as well. Transport sector and real estate activities inhibited GDP growth the most. Transport sector has decreased already for more than two years in a row, primarily due to the increased competition of the Russian cargo ports and recently, of the decreased demand from Russia.

Labour productivity decreased second quarter in a row as the growth of value added decelerated faster than hours worked. At the same time, labour costs increased, therefore, accelerating the growth of unit labour costs.

Although investments decreased by 8%, the drop was not broad-based and came primarily from the agricultural and energy sector. Despite the decrease in investments, these economic activities are among the largest investors in Estonia. Households increased their investments in dwellings, while government investments remained roughly on the same level as a year ago.

Deceleration of the growth of electronics production, as well as problems with the Russian market inhibited the growth of total exports from Estonia. Exports of goods and services increased by 2%. Deceleration of the export growth was expected. Together with the deceleration of the growth of production volume and drop in investments, import decreased, as well.

The growth of household consumption decelerated to 2% in the first quarter this year, primarily due to the decrease in consumption of alcoholic beverages and tobacco and less consumption on housing.Consumption of alcoholic beverages and tobacco has decreased already a year in a row. Increased consumption of foodstuff, transport, recreation, restaurants’ and hotels’ goods and services contributed the most to the household consumption referring to the increase in households’ real income. Household consumption has been and will be the main contributor to the economic growth in the coming quarters.

Weak industrial sector data in April refer to the possible continued deceleration of economic growth in the second quarter. Despite of that we are not going to revise our GDP forecast for this year (2.1%), yet. Strong decrease in export to Russia continues in the coming quarters, but the economy in Europe is gradually recovering.

Looking more closely at the Estonian economy, it can be seen that the growth in Estonia in 2014 came primarily from the domestic market, said Ardo Hansson, Governor of Eesti Pank in his speech to the Estonian Parliament on May 26, 2015.

Domestic consumption was lifted by rising employment, falling unemployment, and strong wage growth and a simultaneous fall in prices. The economy grew faster in 2014 than in 2013, but it should be remembered that no return to the growth rates seen in the boom years of the last decade is to be expected.

It may be hard to get used to the idea of lower growth rates, but economic truths cannot be denied. The Estonian economy and Estonian demographics are in a different phase of development now, and long-term sustainable growth is notably lower at 3–4%.

Consumer price inflation in Estonia fell below zero in June 2014 for the first time since the crisis. Four years ago prices fell across a wide range of goods and services, but last year the fall in prices was mainly caused by cheaper energy and food. Eesti Pank is not forecasting any rise in prices this year, but rising wages will put upward pressure on the prices of domestic goods and services.

One reason for the rapidly rising labour costs has been the decline in the working age population, but faster growth in wages than in productivity could endanger the competitiveness of the Estonian economy in the longer term. Companies are for now able to cover the rapidly rising labour costs from their profit buffers, but in the longer perspective this will inevitably cease to be possible. Reduced profits threaten the ability of companies to invest in higher productivity and in the human capital needed for more complex and higher-value work. I have often said, and it bears repeating again today, that the key challenge in the development of the Estonian economy is how more complex work than hitherto can be accomplished with a smaller workforce.

The rapid rises in wage income and household consumption boosted tax revenues in 2014, which in turn improved the state finances and helped lift the state budget to a small surplus in 2014. Going forward it is important that the government stick to the target agreed in the budget strategy of maintaining a nominal budget balance and building up its reserves.

Here I should note that the purchases of bonds by central banks and the resulting fall in interest rates have encouraged the belief or the conviction that there is a free lunch to be had and Estonia is denying itself a feed because the Estonian state does not issue bonds. We all know full well that there is no such thing as a free lunch. Even were the central bank to purchase one quarter of the bonds issued by the state, those bonds would still constitute a debt that would have to be paid back eventually.

Financing new investment through state bonds could well prove inefficient and harmful for the Estonian economy as a whole, even if the investments are in good projects. The low unemployment and rapid wage rises that we see at the moment would cause a large part of the extra money gained from the emission of state bonds to be lost, as infrastructure projects would cost much more than before. Large state construction projects that can only be temporary in nature would also cause economic and social problems in Estonia, because once the large projects finish, a great number of those working on them would find themselves unemployed, having left jobs in other sectors.

It must be understood that Estonia already profits from the purchases of bonds by the central banks of the euro area. Financial markets act as a series of communicating vessels, so that when interest rates in one area fall, the effect is passed on to other areas. The lower interest rates in the euro area mean that Estonian companies and households can borrow more cheaply, and were it necessary the Estonian state could also borrow more cheaply. If easier financing conditions spur on the European economy, Estonian exporters will be among the winners, and this is the goal towards which the bond purchase programme is striving.

In summarising the Estonian economy I should say our economy has grown at a satisfactory speed overall, as there is no little uncertainty in the global economy and there are protracted problems with growth in several of Estonia’s export markets.

The tensions in geopolitical relations last year, including the trade sanctions between the European Union and Russia, have left a mark on the Estonian economy, though fortunately not a deep one.

Estonian exporters deserve recognition for the flexibility they have shown in finding new markets. Exports have managed to increase even as prices have been generally falling in foreign markets, while local production costs have been driven up by rapidly rising wages. That the market share for Estonian goods and services in the trade with partner countries has increased shows that Estonian export items are competitive in international markets.

Source: Speech of the Governor of Eesti Pank to the Riigikogu at the presentation of Eesti Pank’s Annual Report 2014

According to the flash estimates of Statistics Estonia, the gross domestic product (GDP) of Estonia increased 1.2% in the 1st quarter of 2015 compared to the 1st quarter of 2014.

In the 1st quarter of 2015, the seasonally and working-day adjusted GDP decreased by 0.3% compared to the previous quarter and increased by 1.8% compared to the 1st quarter of 2014.

According to the preliminary calculations, manufacturing was the main contributor to the GDP growth in the 1st quarter of 2015, mainly due to the increase in the manufacture of electronic equipment, mineral products and wood products. The value added of manufacturing depends substantially on exports. The real growth of the export of goods of the total economy was 3% in the 1st quarter, mainly due to the increase in the export of electronic equipment and mineral products. At the same time, the real import of goods grew 1%.

In addition, the GDP growth in the 1st quarter was positively influenced by the net taxes of products. There were increased receipts at current prices of value added tax and excise taxes on fuel and tobacco. However, receipts of alcohol excise decreased compared to the 1st quarter of 2014. Payments of subsidies decreased as well.

In the 1st quarter of 2015, the Estonian economy was inhibited the most by the decrease in value added in transport.

The flash estimate is calculated only by production method using the information from the Estonian Tax and Customs Board and data derived from monthly statistical surveys. Therefore, the flash estimate may differ from the revised estimates of the GDP, which are calculated by expenditure, production and income method using quarterly data. The revised estimates for the 1st quarter of 2015 will be published by Statistics Estonia on 9 June 2015.

The flash estimate1 put the Estonian current account at 62 million euros in deficit in March 2015. Exports of both goods and services were higher than in March last year and imports of goods were also higher, though imports of services were smaller than a year ago. Foreign investment dividends paid and received dominated in incomes.

The current and capital accounts were also negative in March. This means that the Estonian economy was a net borrower from the rest of the world, so the country as a whole received more resources from abroad than it invested there.

Eesti Pank publishes the flash estimate of the balance of payments monthly for the last month but one. From January 2015 Eesti Pank accompanies the publication of the flash estimate with a short comment. The statistics on the first quarter of 2015 will be published with a comment on 9 June.

1 The quarterly balance of payments is compiled from a combined system of representative primary data sources, including surveys of companies, while the monthly balance of payments draws from a considerably smaller database. Although the monthly report uses as much data available for the month reported as possible, including administrative data sources and reports on international payments, it is subjective to a certain degree, which is why it is called an estimate. Once the quarterly balance of payments is released, the monthly balances of payments are adjusted accordingly.

According to the flash estimates of Statistics Estonia, GDP decelerated to 1.2% YoY in the first quarter of 2015. The seasonally and working-day adjusted GDP increased by 1.8% YoY. Compared to the previous quarter, economic growth decreased by 0.3%.

Deceleration of export growth and decrease in investments slowed the economic growth the most. Exports of goods grew by 3% in real terms in the first quarter. Decreased export volumes to Russia had the largest negative impact, but it was partially compensated by the fast growth of electronics exports. Electronic equipment has considerable contribution to the export growth and, in turn, to the economic growth. Unfortunately the orders of electronic equipment have decreased and its export has decelerated this year.

Although export growth has decelerated, the growth of import was even weaker in the first quarter, only 1%. This referred to the continuous decline in investments. In the second half of last year import growth accelerated, but that did not increase investments, which means that a large share of imported goods was used in intermediate consumption.

Private consumption contributed the most to the economic growth, supported by robust growth of real wages and solid consumer confidence. Lower prices of motor fuel helped consumers to save money or spend it on something alternative. Increased receipts of excise taxes and value added tax made a strong contribution to the GDP growth.

We expect Estonian economy to grow by 2.1% in 2015, mainly supported by strong private consumption. Steep decrease in exports to Russia will continue. Meanwhile the companies have increased their exports to other countries – to Sweden, the Netherlands, the US, Poland and Spain. If orders of electronic equipment will not turn to the growth in the coming months, it will have a negative impact both on our exports, as well as, on our economic growth. Although foreign demand will be weaker this year, we are more optimistic than few months ago. The European economy is improving, which gradually gives more opportunities to our exporters. We expect weaker euro to have a positive impact on our competitiveness and exports, but it will only affect about 1/3 of the exports, which is denominated in US dollars. Enterprise investments will remain modest, whereas public sector investments are expected to grow.